ITAD BIR Ruling No. 081-11

March 11, 2011 ITAD BIR RULING NO. 081-11 Article 12, Philippines-Japan Tax Treaty, as amended by its Protocol; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended; BIR Ruling No. ITAD-48-10; BIR Ruling No. ITAD-011-10 PHCP, Inc. Special Export Processing Zone FCIE Barangay Langkaan Dasmarias, Cavite Attention: Ms. Melissa M. Del Rosario Accounting Manager Authorized Representative Gentlemen : This refers to your letter dated July 1, 2010 requesting confirmation that royalties received by HITACHI CABLE PRECISION CO., LTD. (HCPC) from PHCP, INC. (PHCP) are subject to ten percent preferential tax rate pursuant to Article 12 of the Convention Between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-Japan tax treaty), as amended by a Protocol which took effect on January 1, 2009. SEACTH It is represented that HCPC is a foreign corporation organized and existing under the laws of Japan as evidenced by its Articles of Incorporation and by the information contained in the register issued by the Yamagata Legal Affairs Bureau in Japan on April 21, 2010; that HCPC's principal office is at 901, Hosen-machi, Yonezawa-shi, Yamagata-ken, Japan; that HCPC is not registered as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company dated July 28, 2010 issued by the Securities and Exchange Commission (SEC); that, on the other hand, PHCP is a domestic corporation with principal address at FCIE, PEZA Drive, Langkaan, Dasmarias, Cavite, Philippines; and that PHCP is registered with the Philippine Economic Zone Authority (PEZA) as an ecozone export enterprise under amended Certificate of Registration No. 95-11 dated August 24, 2004. It is further represented that on December 1, 2004, HCPC and PHCP entered into a License and Technical Assistance Agreement (Agreement) wherein HCPC grants PHCP a non-exclusive, non-transferable and non-sublicensable license to manufacture lead frames (the Licensed Products) in the Philippines and to sell them in all countries in the world; that upon the request of PHCP during the term of the Agreement, HCPC shall supply Technical Information 1 to PHCP, which is available to and in use by HCPC for its commercial production of the Licensed Products; that in consideration thereof, PHCP shall pay HCPC a royalty of three percent (3%) based on the Net Selling Price 2 of the Licensed Products sold or otherwise disposed of by PHCP; that the royalty shall be paid for the whole ten years from the commencing date of commercial production of the Licensed Products; that the royalty shall be reviewed by the parties every year and, if not reviewed, shall continue to be valid for further periods of one year; that the royalty shall be paid semi-annually and within sixty days from March 31 and September 30 of each calendar year and within sixty days after the date of expiration or termination of the Agreement; that the royalty shall be paid by telegraphic transfer to HCPC's bank account at the bank of Tokyo-Mitsubishi, Tokyo Office, without deduction of remittance cost; and that the royalty shall be paid in U.S. dollars converted from Philippine pesos quoted on the foreign's exchange market in the Philippines on date of remittance of the royalty. It is further represented that the Agreement entered into force on December 1, 2004, and shall continue to be effective for ten (10) years from the commencing date of commercial production, unless earlier terminated; that the Agreement shall be automatically renewed with review and amendment, if necessary, every year for an additional one (1) year period unless either party gives the other party a written notice of its intention to terminate the Agreement at least two (2) months prior to the expiration of the original term of the Agreement or any successive annual period thereafter. It is further represented that the transaction subject of the application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by PHCP on August 20, 2010. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general to the subject royalty. It provides: AcHEaS "Section 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that the royalty may be exempt from income tax or partially exempt (if subject to a reduced rate only) to the extent required by any tax treaty obligation binding upon the Philippine Government, viz. : "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. xxx xxx xxx" Thus, for this purpose, you invoke the provisions of the Philippines-Japan tax treaty, as amended. Article 12 thereof provides: "Article 12 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: a) 15 per cent of the gross amount of the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; b) 25 per cent of the gross amount of the royalties in all other cases. xxx xxx xxx 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. aDSIHc 4. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films and films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience. xxx xxx xxx." The Protocol amending the Philippines-Japan tax treaty, which took effect on January 1, 2009, reduced the rate of income tax on royalties covered by subparagraph (b) from 25 percent to 10 percent, thus: "ARTICLE V Paragraph (2) of Article 12 of the Convention shall be deleted and replaced by the following: (2) However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: (a) 15 per cent of the gross amount of the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; (b) 10 per cent of the gross amount of the royalties in all other cases." Under paragraphs 2 and 3, royalties arising in the Philippines and derived by a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed thereon shall not exceed (a) 10 percent if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer areas of investment; (b) 15 percent if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and 25 percent of the gross amount of the royalties, in all other cases. However, beginning January 1, 2009, royalties for the use of, or the right to use, any copyright of literary, artistic or scientific work (except cinematograph films and films or tapes for radio or television broadcasting), any patent, trade mark, designs or model, plan, secret formula or process, or information concerning industrial, commercial or scientific experience (know-how), and payments or rentals for the use or the right to use of industrial, commercial or scientific equipment, which are subject previously to a tax of 25 percent are now subject to tax at 10 percent. This being the case, this Office is of the opinion and so holds that the said royalty payments by PHCP to HCPC under the existing Agreement , being essentially royalties for the use of or the right to use of know-how shall be subject to tax at the rate of 25 percent of the gross amount thereof for the royalty arising or paid before January 1, 2009, and at the rate of 10 percent of the gross amount of the royalty for royalty arising or paid on and after January 1, 2009, until the expiration of the Agreement on November 30, 2014. (BIR Ruling No. ITAD-011-10 dated June 16, 2010; BIR Ruling No. ITAD 48-10 dated October 6, 2010) As regards the imposition of the value-added tax (VAT) on the transfer of license and technical know-how by HCPC to PHCP, please be informed that Section 108 (A) of the Tax Code of 1997, as amended, provides as follows: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Emphasis supplied) xxx xxx xxx" However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : "Special laws may certainly exempt transactions from the VAT. 3 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory . This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of PD 66 and RA 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 (q) [now Section 109 (K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of royalty by PHCP, being a PEZA-registered enterprise, to HCPC under the Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the facts as represented and shall only apply insofar as the royalty aspect is concerned. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. cIACaT Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Technical Information" shall consist of the following: a. Purchase specification of raw materials and components, and other materials if any; b. Design instruction; c. Manufacturing instruction; d. Test and inspection standards; e. Instruction for quality control; f. Maintenance instructions on machinery and equipment; g. Advice on the selection and purchase of machinery and equipment if required by PHCP; and h. Any other information necessary to manufacture the Licensed Products. 2. "Net Selling Price" shall mean the gross selling price of the Licensed Products as invoiced by PHCP, less the following items: (a) any taxes levied on the Licensed Products and the transactions thereof; and (b) trade discounts and credits allowed for the returned Licensed Products. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].